May 2020 Markets Review Next item Advice in the Age of Pandemic

May 2020 Markets Review

Markets have continued to rally off the recent lows. The nearly 11-year bull market came to an abrupt end in February, as market participants sold risk assets in response to a rapidly spreading pandemic. The S&P 500 dropped 34% in 23 trading sessions before bottoming out on March 23rd. Since then, the S&P 500 has gained 37%.

Confirmed Cases of COVID-19 in the United States
Source: COVID-19 Dashboard by the Center for Systems Science and Engineering at Johns Hopkins University

On the date of the recent market bottom, there were 43,268 confirmed cases of COVID-19 in the U.S. Since then, the number of cases has tragically risen to 1.7 million, an increase of nearly 40x. So what happened? Why is the market rallying in the face of a global pandemic that has killed 356,606 people, shut down the economy, caused over 30 million job losses in the U.S., has no vaccine or cure, and is far from contained – especially in emerging market countries such as Brazil and Russia?

Here are some possible explanations and thoughts on the subject:

“The market overreacted”

  • Markets hate uncertainty. When there are unknown variables that haven’t been or cannot be modeled, investors with short-term outlooks flee risk assets for safe havens such as Treasuries and gold. 
  • As market participants adapted and accepted the current environment, willingness to take on equity market risk increased.
  • Like any free market, prices are based on supply and demand. Sellers became willing to sell at any price, and only the bravest of buyers were willing to add capital to equity markets.
  • Lake Street was a net buyer of equities during this downturn, as we:
    • Took advantage of dislocated markets to rebalance
    • Harvested losses
    • Put fresh capital to work for clients who had cash on the sidelines from recent liquidity events

“The market is forward looking”

  • The future looked very different on February 19th compared to March 23rd – the number of new COVID-19 cases was exploding, the economy came to a screeching halt, and companies issued lower guidance  (or withdrew guidance entirely)
  • Since March 23rd, the future has started to look brighter –
    • Monetary and fiscal stimulus has supported the economy during the shutdown, held interest rates low, and helped those out of work bridge the gap of temporary job loss
    • Economy beginning to reopen
      • Economic activity rebounding quickly
      • Continuing unemployment claims dropped during the last week of May

“We’re going to see another selloff as a second wave of cases spreads”

  • Maybe! But that is impossible to predict. Attempting to time getting in and out of the market, especially after paying taxes, is not a winning proposition over time
  • Continue to rebalance and take advantage of volatility through tax loss harvesting/rebalancing/deploying

Market Timing

As we look at timing the markets, let’s examine four scenarios, assuming you start with $1M invested 60% in the MSCI All Country World Index (ACWI)* and 40% in the Barclays Aggregate Bond Index** on January 1st with $0 gain/loss.

  1. Sold equities at the low point and added to bonds
    • The portfolio would now be worth about $850k
    • –15.2% return YTD
  2. Held until today with no rebalancing
    • The portfolio would now be worth about $965k
    • –3.5% return YTD
  3. Rebalanced at the equity market low point
    • The portfolio would now be worth about $985k
    • –1.5% return YTD
  4. Rebalanced and tax-loss harvested at the equity market low point
    • The portfolio would now be worth about $985k
    • –1.5% return YTD
    • Realized short-term capital loss of $188k, which could be worth up to $75k assuming 40% tax rate, which will vary depending on the specific tax situation
    • Assuming the tax loss is valued at $75k, the portfolio is worth $1.06M, an increase of 6.1% for the year!

Outlook

Through the end of 2020, there are a few items that are sure to drive market sentiment over the short term:

  • U.S./China trade relations
  • U.S. Presidential Election
  • A potential “Second Wave” of COVID cases

Each of these, as well as many other unforeseen events, will certainly have short-term impacts on the market. We will remain focused on long-term returns, driven by a disciplined approach to rebalancing, loss harvesting, and building portfolios intended to generate optimal risk-adjusted returns.

* The MSCI All Country World Index (ACWI) is a market capitalization weighted index designed to provide a broad measure of equity-market performance throughout the world. The MSCI ACWI is maintained by Morgan Stanley Capital International (MSCI) and is comprised of stocks from 23 developed countries and 24 emerging markets.

**The Barclays Aggregate Bond Index is an index that broadly tracks nearly the entire U.S. investment-grade bond market.  Also known as the “BarCap Aggregate” or “Barclays Agg,” the Barclays Capital Aggregate Bond Index comprises about $15 trillion worth of bonds and includes the entire space of domestic, investment-grade, fixed-income securities traded in the United States.